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Emerging markets: Mexico transforming, becoming a rising star

For more than two decades, a host of factors have held back Mexico’s economy. These include:

a poor educational system

high crime levels

an ineffective criminal justice system

a faulty tax collection system

corruption

Though not completely resolved, these issues generally have shown signs of improvement in recent years. Mexican officials, led by President Enrique Peña Nieto, have created an anticorruption task force, along with other efforts to address the country’s flagging educational system and rampant gang violence.

Perhaps most notably, Mexico's Congress also approved a measure of labor market reform in November 2012 — the first substantial change in the country’s labor law since its creation in the 1970s. In the coming years, the reform may generate up to 1.2 million new jobs and potentially contribute between 1.5 and 2.0 percentage points to economic growth, according to research published by Barclays. We believe this reform package could help Mexico’s economy compete at a level that is on par with the developed world.

On the ground: Signs of momentum

Of course, some of Mexico’s problems won’t be solved overnight. But we believe that positive trends are offsetting Mexico’s ills. Notable change is happening within business and industry, in addition to the government-led reforms mentioned above. In the manufacturing sector, for instance, major automobile makers such as Honda, Nissan, and Mazda are now running factories within Mexico’s borders.

This is good news for North American trading partners, especially the United States, because cars manufactured in Mexico have a much shorter delivery time compared to shipments from overseas. This year, Mexican factories are expected to produce a total of three million automobiles, putting Mexico among the five biggest auto exporters worldwide. (Data: The Economist.)

Other trends worth watching include:

Local credit is opening up, giving businesses and consumers better access to financing.

Chinese wages are rising, making Mexican wages increasingly more competitive by comparison (the illustration below helps make this point).

China vs. Mexico: Wage growth over time

Data: HSBC, May 2013. Most recent data available.

Chinese wages are on the rise, and growing at a fast clip. Mexican wages have grown, too but at a slower pace. Here’s a look at the growth in average hourly pay for factory laborers. Figures are based on wages in in U.S. dollars, to facilitate comparison for U.S.-based businesses and investors.

Exports a bright spot, but not the only story

Based on research, the Mexican economy appears poised for a period of strong performance. Mexican exporters are gaining market share in U. S., which could result in billions of dollars' worth of additional trade in the coming years. But exports are just one side of the story.

At a more fundamental level, we believe Mexico shows:

a stable macroeconomic framework

solid financial institutions (including an autonomous central bank) that can support the needs of a dynamic economy

a business culture that is highly compatible with those of developed countries.

Taken together, these components are already producing results, lifting Mexico’s economic growth rate and putting it near the top of fellow countries within the Organization for Economic Cooperation and Development (OECD). The table below, based on data published in early 2013, shows the Mexican economy among the 10 strongest OECD countries in recent years.

GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, and is usually calculated on an annual basis.

Table above is for illustrative purposes only.

Our perspective as investors

The Delaware Investments fixed income team began 2013 with a relatively positive view on Mexico, and our optimism continues through today. Despite the social issues mentioned above, we believe the Mexican government has shown discipline in keeping its fiscal picture from deteriorating, even in the wake of the 2008-2009 global recession.

Furthermore, the Bank of Mexico (the country’s central bank) has used monetary policy effectively, in our opinion, restoring the economy to a normal growth rate while keeping inflation contained.

Across the portfolios we manage, Mexican positions are concentrated chiefly in government and corporate debt. This reflects our view that macroeconomic fundamentals are sound, and that officials have plenty of flexible policy tools at their disposal. On the corporate side, we believe credit fundamentals are robust and liquidity is abundant.

What’s more, Mexico presents opportunities across a diverse collection of industries — autos get a big share of the headlines, but significant activity is happening in electronics, paper products, kitchen appliances, and chemicals as well (among others).

A word about corruption: Challenging, but not squelching investor optimism

Doing business in Mexico can be frustrating — obtaining a construction permit, for instance, can take two-and-a-half months; paying a traffic ticket can take an entire day at the police station. All of this bureaucracy has bred serious corruption, and a cash-based, under-the-table economy has long been a shadowy part of Mexican life. According to some estimates published recently in The Economist, Mexican households spend about 32 billion pesos a year on bribes (the equivalent of 2.5 billion U.S. dollars).

Surprisingly, foreign investment into Mexico has continued at a healthy pace despite the heavy corruption, suggesting, as we believe, that investors are not particularly affected by corruption worries. Investors appear to be focusing on the country’s stable economic framework instead.

The views expressed represent the investment Manager’s assessment of the market environment as of June 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s current views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.>

The Fund may also be subject to prepayment risk, the risk that the principal of a bond that is held by a portfolio will be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

Interest payments on inflation-indexed debt securities will vary as the principal and/or interest is adjusted for inflation.

International fixed income investments are subject to currency risk. Adverse changes in foreign currency exchange rates may reduce or eliminate any gains provided by investments that are denominated in foreign currencies and may increase losses.

More from Wen-Dar Chen

Wen-Dar Chen biography

Wen-Dar Chen, Ph.D.

Senior Vice President, Senior Portfolio Manager and Analyst

Wen-Dar Chen, Ph.D., is a member of the firm’s taxable fixed income portfolio management team with primary responsibility for constructing global investment themes, international portfolio strategic asset allocation, and risk management. He has specialized in quantitative fixed income investments since 1986. Before he joined Macquarie Investment Management (MIM) in mid-2004 as a senior international debt analyst, he was a quantitative analyst in global asset-backed securities, credit strategies, and portfolio strategies at J.P. Morgan Securities. Since 1998, he has worked to promote the asset-backed securities business in Asia, and published the book, Asset-Backed Securitization — Theory and Practice, in Asia in 2002. He worked at Salomon Brothers from 1993 to 1996, and Lehman Brothers from 1990 to 1993, during which time he gained experience with government securities trading desks, proprietary trading of structured products, financial strategies, and index strategies groups. Dr. Chen’s degrees include a bachelor’s degree in atmospheric sciences from the National Taiwan University, a master’s degree in meteorology from the South Dakota School of Mines and Technology, and a Ph.D. in geophysical fluid dynamics from Princeton University.

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